Archive for September, 2011

Apropos of absolutely nothing tax related, I highly recommend you take two minutes out of your October 15th push and soak in the images below. We here at Double-Taxation spent a much-needed lunch break enjoying one of our favorite mountain bike rides along the Government Trail in Aspen today. The colors, as you’ll see, are simply otherworldly.

The IRS has published final regulations providing that after December 31, 2010, all individuals who prepare all or substantially all of a tax return or claim for refund for compensation must have a PTIN and must use that PTIN as their sole identifying number. The PTIN comes at the price of a $50 user fee to the IRS, plus any IRS approved fee charged by the third-party vendor, to initially obtain and to annually renew a PTIN.

Only attorneys, certified public accountants, enrolled agents, registered tax return preparers, and individuals authorized under § 1.6109-2(h) are eligible to receive a PTIN.

Renewal Process

The IRS has decided that all PTINs must be renewed on a calendar year basis using the IRS’s online PTIN application available at www.irs.govor paper application, Form W-12, IRS Paid Preparer Tax Identification Number (PTIN) Application and pay the required fee (currently $64.25, $50.00 IRS user fee plus $14.25 vendor fee) after October 15th and before January 1st each year.

PTINs renewed during this period will be valid from January 1st through December 31st of the following calendar year. PTINs obtained or renewed during a calendar year will expire on December 31st of that year.

Individuals obtaining a new PTIN after October 15th will have the option of receiving a PTIN for the current calendar year or the following calendar year. Individuals who choose to receive a PTIN for the current calendar year will be required to renew their PTIN before January 1st to prepare returns during the following calendar year. Individuals who choose to receive a PTIN for the following calendar year may not prepare tax returns for compensation during the remainder of the current calendar year. Instead, the PTINs issued to these individuals will be valid for the following calendar year.

To assist with the transition to a calendar year renewal period, the IRS has determined that PTINs issued after September 27, 2010 and before October 16, 2011 will expire on December 31, 2011.

The prevailing attitude among most tax advisers is that if given their druthers, small businesses should be established as an S corporation or LLC. Setting up a business as a “C” corporation, with its seemingly inefficient potential for double-taxation (product placement!), is often not given much in the way of consideration.

According to a recent study, however, there are nearly $1.6 million small businesses currently operating as C corporations. With treatment as an S corporation or LLC readily available to most taxpayers, why would so many businesses opt for the supposedly inefficient taxing regime imposed by subchapter C?

Now that we’ve had some time for the smoke to clear with regards to the President’s most recent proposal for tax reform (see earlier proposals here and here) it’s time for a quick overview as to what’s happened, and where we’re headed.

So what went down last Monday?

The President rolled out his $3 trillion federal budget Deficit Reduction Plan. It’s a veritable economic stew filled with succulent spending cuts, tasty tax increases, and robust revenue raisers. And much like my Mom’s mystery meat-and-vegetable concoction, many have had a difficult time choking it down. The plan — which targets the amount of tax paid by the nation’s cultural elite — has been met with the expected Republican backlash, including accusations of class warfare and the standard shortsighted, incomprehensible rhetoric from Bill O’Reilly.[1]

So what does this mean to me?

Perhaps the most important thing is this: the plan takes aim at “wealthy taxpayers.” Unfortunately, whether or not a taxpayer is “wealthy” depends on which tax proposal we’re talking about. As you’ll see below, for some purposes of the proposal, you would be considered wealthy if your taxable income exceeds $200,000, while for other purposes, you’ll need to have taxable income in excess of $1,000,000 to meet the “wealthy” standard.

How do these proposals effect the Bush-era tax cuts?

If the President were to do nothing, the Bush-era tax cuts are set to expire after December 31, 2012. As a result, the top two tax rates would revert to 36 and 39.6 percent.

The most recent proposal would allow these two higher rates to return for 2013 and beyond, but only for “wealthy” taxpayers of the $200,000 variety. In other words, if your taxable income exceeds $200,000 ($250,000 for MFJ) in 2012, you’ll be paying tax at up to a 39.6 percent rate.

Will we still have the favorable 15 percent rates on long-term capital gains and qualified dividends?

This isn’t entirely clear, but even if the 15 percent rates remain in the taxing structure, it likely won’t remain for everyone. The goal of the President’s proposed tax reform is to require a wealthy taxpayer who generates mostly long-term capital gains or qualified dividend income to pay tax at an effective rate much closer to 35 percent than 15 percent. So while taxpayers with income below $200,000 may well continue to enjoy the benefits of the current 15 percent rates, taxpayers with more than $200,000 of taxable income likely will not.

Is this where the “Buffet Rule” comes in?

Precisely. While the “Buffet Rule” is not a specific proposal in terms of increased tax rates or a reduction in certain deductions, the goal is to insure that individuals with taxable income in excess of $1,000,000 pay tax at an effective rate of close to 35 percent. This could be accomplished in a number of ways; by increasing the graduated tax rates, phasing out certain deductions, or incorporating a second alternative to the alternative minimum tax. At this moment, the President is leaving it to Congress to figure out the details and methodology.

The Buffet Rule wouldn’t have a tremendous impact on taxpayers with more than $1,000,000 of “ordinary” taxable income, as this income is already taxed at the highest possible rates. Rather, the Buffet Rule takes aim at wealthy individuals earning the majority of their taxable income from long-term capital gains and qualified dividends taxed at preferential rates. These taxpayers could see a marked jump in their tax liability under this hypothetical new minimum tax should the President’s proposals become law.

Another alternative minimum tax? Are you #*@!ing serious?

Unfortunately, yes. While the President says he wants to overhaul and simplify the Code, implementing the Buffet Rule would most assuredly complicate matters. Congress would likely have to implement an entirely independent taxable income computation for individuals with taxable income in excess of $1,000,000 to guarantee the individual pays tax at the desired effective rate. Any such calculation would likely have to take into account the myriad of exclusions, above-the-line deductions, itemized deductions, and tax credits taxpayers are currently entitled to, generating an exponential increase in administrative headaches, late nights, and billable hours for tax advisors.

Are there any other individuals proposals I should know about?

The President’s proposal includes a plan to limit the tax benefit of itemized deductions for individuals with taxable income in excess of $200,000 ($250,000 MFJ) to 28 percent (as opposed to a current maximum benefit of 35 percent). While this proposal doesn’t appear to be integrated with the “Buffet Rule,” it would surely have to work in lockstep with any alternative alternative minimum tax. As mentioned, however, this rule targets individuals with taxable income in excess of $250,000, while the Buffet Rule is meant for wealthy individuals of the $1,000,000 variety.

What else makes the plan so complicated?

Let’s rehash what we’ve already discussed. If all the President’s proposals become law, we could potentially have three independent computations of tax going on in 2013 and beyond:

1. Taxable income < $200,000 ($250,000 if MFJ): Would still have a top rate of 35 percent, and it appears, would still be entitled to the 15 percent tax rate on long-term capital gains and qualified dividends.

2. Taxable income > $200,000 but less than $1,000,000: Would fall into the “first tier” of wealthy taxpayers. These individuals would likely see their top rate revert to the old 39.6 percent, with the preferential rates on long-term capital gains or qualified dividends either being eliminated entirely or moved to a 20-25 percent rate. These individuals would also be subject to the additional 0.9 percent Medicare tax on wages and self employment income and the additional 3.8 percent Medicare tax on unearned income already enacted into law. Finally, these individuals would also be subject to the 28 percent cap on their itemized deductions. Good luck preparing/reviewing that tax return.

3. Taxable income > $1,000,000: Will have to contend with all of the items discussed in #2 above, but will also have to wrestle with a separate computation to reach the goals of the “Buffet Rule.” Again, this sounds like a lot of moving parts that will challenge tax software and practitioners alike.

Are there any tax changes for corporations in the plan?

Right now, the President is showing an inclination to reduce corporate tax rates as long as certain loopholes are closed. No specific tax rates have been discussed, but it’s clear the President is prepared to provide some incentive for US corporations to remain onshore rather than seeking out greener pastures overseas.

[1]In response to the President’s proposal, O’Reilly said that an increased tax rate on the wealthy amounts to a “tax on achievement.” “And when you tax achievement,” O’Reilly added, “some of the achievers will pack it.” This statement is both stupid and unfounded, particularly in light of two facts:

1. O’Reilly made his vast, inexplicable fortune at a time when the top tax rate was 39.6 percent under President Clinton. As such, he’s no stranger to the proposed rate, and did he “pack it in” during the Clinton regime? No, he opted instead to slap a stupid logo on every piece of crappy merchandise imaginable and sell it on his website, giving the world meaningful products such as the “patriot coffee mug” and the “patriot hat.”

2. Effective tax rates have been as high as 90 percent in this country, and it’s safe to say that the majority of achievers, even when faced with the prospect of turning the majority of their hard-earned income over to the government, didn’t simply shrug their collective shoulders, pull the plug on their life’s work, and take a job flipping burgers.

On Monday, it appears the President is poised to propose replacing the Alternative Minimum Tax on individuals with what is being called the “Buffet Rule,” which will impose a minimum tax rate on individuals with taxable income in excess of $1,000,000. The goal is to insure that high-income taxpayers pay the same percentage of income as middle-class earners, a characteristic of the taxing system that Warren Buffett has repeatedly called for.

No details are currently available regarding the proposal, but we’ll be all over it when they are.

As you may have heard, the Small Business Jobs Act of 2010 removed cell phones from the dreaded “listed property” classification. While that was a step in the right direction, the IRS did little to piggyback on the law change and clarify what the removal actually means to employers and employees.

Well, here it is…as long as an employer issues cell phones to its employees for work-related purposes — taking client calls, taking calls from the employer, etc… — and not compensatory purposes such as attracting talent or improve the morale of existing employees, the entire value of the cell phone is tax-free to the employee. The business use is a working condition fringe excludable to the employee under Section 132(d), and the personal use is treated as a de minimis fringe benefit excludable to the employee under Section 132(a)(4).

This notice provides that, when an employer provides an employee with a cell phone primarily for noncompensatory business reasons, the IRS will treat the employee’s use of the cell phone for reasons related to the employer’s trade or business as a working condition fringe benefit, the value of which is excludable from the employee’s income and, solely for purposes of determining whether the working condition fringe benefit provision in section 132(d) applies, the substantiation requirements that the employee would have to meet in order for a deduction under §162 to be allowable are deemed to be satisfied. In addition, the IRS will treat the value of any personal use of a cell phone provided by the employer primarily for noncompensatory business purposes as excludable from the employee’s income as a de minimis fringe benefit.

Yesterday, however, the White House issued detail regarding the legistlative language and section-by-section analysis of the Act, which included a number of revenue raisers. Now, these particular revenue raisers are nothing new, as the Obama administration has been pushing for them since his election, but they may be enough to insure that the Jobs Act never gets passed in its current form.

Among the more important revenue raisers include:

28 Percent Limitation on Certain Deductions And Exclusions. This section would limit the value of all itemized deductions and certain other tax expenditures for high-income taxpayers by limiting the tax value of otherwise allowable deductions and exclusions to 28 percent. No taxpayer with adjusted gross income under $250,000 for married couples filing jointly (or $200,000 for single taxpayers) would be subject to this limitation. The limitation would affect itemized deductions and certain other tax expenditures that would otherwise reduce taxable income in the 36 or 39.6 percent tax brackets. A similar limitation also would apply under the alternative minimum tax. This section would be effective for taxable years beginning on or after January 1, 2013.

Tax Carried Interest in Investment Partnerships as Ordinary Income. This has been bandied about for years, and it appears Obama is dead-set on making it happen. Current law allows service partners to receive capital gains treatment on labor income without limit, which creates an unfair and inefficient tax preference. This section would tax as ordinary income, and make subject to self-employment tax, a service partner’s share of the income of an investment partnership attributable to a carried interest because such income is derived from the performance of services.

Close Loophole for Corporate Jet Depreciation, General Aviation Aircraft Treated As 7-Year Property. Current law contains a loophole that allows corporate jets to be depreciated faster than jets used by airlines to carry passengers courtesy of bonus depreciation. This section closes this loophole, requiring corporate jets to be depreciated over the same number of years as other aircraft. This section would be effective for taxable years beginning after December 31, 2012.

Repeal of Deduction for Intangible Drilling and Development Costs in the Case of Oil and Gas Wells. This section would not allow expensing of IDCs or 60-month amortization of capitalized IDCs. Instead, IDCs would be capitalized as depreciable or depletable property, depending on the nature of the cost incurred, in accordance with generally applicable rules. This section would repeal current law expensing of IDCs and 60-month amortization of capitalized IDCs effective for costs paid or incurred after December 31, 2012.

Repeal of Percentage Depletion for Oil and Gas Wells. This section would repeal the percentage depletion method available under existing law for recovery of the capital costs of oil and gas wells. Under the percentage depletion method, the amount of the deduction is a statutory percentage of the gross income from the property. Instead of the percentage depletion method, taxpayers would be permitted to claim cost depletion on their adjusted basis, if any, in oil and gas wells. Under the cost depletion method, the basis recovery for a taxable year is proportional to the exhaustion of the property during the year. This method does not permit cost recovery deductions that exceed basis or that are allowable on an accelerated basis. This section would be effective for taxable years beginning after December 31, 2012.

Section 199 Deduction Not Allowed With Respect to Oil, Natural Gas, or Primary Products Thereof. This section would deny the deduction available under existing law with respect to income attributable to domestic production activities (the manufacturing deduction) for oil and gas production. The manufacturing deduction generally is available to all taxpayers that generate qualified production activities income, which under current law includes income from the sale, exchange or disposition of oil, natural gas or primary products thereof produced in the United States. The proposal would retain the overall manufacturing deduction, but exclude from the definition of domestic production gross receipts all gross receipts derived from the sale, exchange or other disposition of oil, natural gas or a primary product thereof. This section would be effective for taxable years beginning after December 31, 2012.

The items in this blog are informational only and are not meant as tax advice. Consult with your tax advisor to determine how any item applies to your situation. A select group of Tax Professionals of WithumSmith+Brown write Double Taxation, and any opinions expressed or implied are not necessarily shared by anyone else at WithumSmith+Brown.

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